Analysing Financial Position

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Define Balance Sheet

The balance sheet is a snapshot, valid for one day only. It gives the net worth of the business, total assets against liabilities. 

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Define Income Statement

An income statement is a summary of a 12 month trading period and gives details of revenues, costs and profits.

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Define Cost of Sales

AKA Variable Direct Costs

Costs directly associated with the production of goods e.g. raw materials 

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Define Expenses

AKA Fixed Indirect Costs

Costs incurred that aren't directly associated with production of goods e.g. rents, salaries

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Gross Profit Margin (GPM)

  • Gross Profit/ Revenue x 100
  • % of revenue which is gross profit
  • Improve this figure by better controlling cost of sales 
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Operating Profit Margin (OPM)

  • Operating Profit/Revenue x 100
  • % of revenue which is operating profit
  • Reduce fixed costs
  • Increase gross profit by decreasing cost of sales which increases operating profit
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ROCE

Operating Profit/(Total Equity + Non-Current liabilities) x 100

  • The amount of money you earn back from an investment
  • Increase profitability
  • Reduce capital employed whilst maintaining return %.
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Current Ratio

Current Assets/Current Liabilites

  • Ideal 1.5-2.
  • Compares the difference between current assets and current liabilities 
  • Includes STOCK
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Gearing

Non Current Liabilities/(Total Equity + Non-Current Liabilities) x 100 

  • Shows how much debt the business has
  • To improve this figure, pay off any existing debts ASAP.
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Payable Days

Payables/Cost of Sales x 365

  • Shows how long it takes to pay creditors
  • Ask suppliers for longer credit terms 
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Receivable Days

Receivables/Revenue x 365

  • Shows how long it takes for debtors to pay the business
  • To improve this figure, reduce credit terms to debtors or increase revenue

RECEIVABLE DAYS NEEDS TO BE LESS THAN PAYABLE DAYS!

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Inventory Turnover

Cost of Sales/Average Stock Held

  • Shows how much capital is tied up in stock
  • To improve this figure, sell off existing stocks and reduce product range
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Why is ratio analysis valuable?

  • Ratio analysis provides stakeholders with an insight into the performance of the business over a set period of time 
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What else is needed in ratio analysis?

  • PREVIOUS YEARS DATA: To enable trend calculations. To see a steadily improving ROCE would reassure investors 
  • INDUSTRY DATA: Comparing like for like gives a more informed judgement of performance
  • OTHER INDUSTRY DATA: Compare with alternative industries experiencing similar external influences e.g. rapid growth
  • MARKET DATA: More context
  • MARKET SHARE: Market leaders need to have stronger results
  • HR DATA: Workforce shortages or problems- LT impact
  • ECONOMIC ENVIRONMENT: Boom vs Recession. Are results in line with inflation?
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